Eurozone sovereign debt crisis through the eyes of a bond trader

I have a bond-trading friend who has done quite well for himself thanks to a habit of being in the wrong place at the wrong time —Russia in 1998, Argentina in 2001. When the Greek debt crisis began in 2009, he thought he saw a similar opportunity.

But this crisis is not turning out the way he expected, he says, over lunch in his apartment, a lovely old flat full of art and air and orchids, all conjured out of Argentine obligaciones. What began as gardenvariety sovereign finance trouble has now been whipped into a major political crisis, he says, and he doesn't like political crises.

For a trader, they're too unpredictable, too dangerous. You can't calculate the risk. Although he and his wife (who works with him), talk about the unpredictable nature of the euro crisis, the analogies they use — the English Civil War, World War I — make the crisis sound less unpredictable than inevitable — one of those perfect storms in which inadequate institutions led by inept leaders find a way to extract the full potential of a bad situation.

Franco-German Schadenfreude

In the beginning, the Greek debt crisis didn't look all that serious, he says. The amount needed to bail out the Greeks was relatively small: some of the German banks bailed out in the last financial crisis had been given more money than the Greek debt would require. But in his view, German chancellor Angela Merkel chose to take some political advantage with her speeches about the lazy Greeks, he says, which postponed a settlement and helped raise the profile of the crisis enough that traders started looking at the bonds of other southern European countries.

Eventually, even the Germans came around to the idea that the debt needed to be restructured and the bondholders would have to "take a haircut" — that is, forgive a large part of the principle.

Then the French had their turn to be apparently irrational, by opposing the haircut. But only apparently: everyone knows the big French banks hold billions in Greek debt, he says, but not so many have realised that they also sold billions of that debt to much smaller entities, such as insurance companies and pension funds.

A major write-down might lead to a lot of technical insolvencies by wiping away their reserve capital, and lead to some awkward questions of the powers that be. Politicians here are painfully aware that the French are less understanding than the Americans or the British about someone gambling away their retirement.

Anatomy of a Crisis

There are other structural problems too, that have made a deal hard to reach, he says. First, credit-default swaps, as side-bets on the performance of a real asset, pay off whenever something happens, a bit like bets at a horse race. Even if the lender and borrower both agreed to a restructuring, something someone might say or do might be interpreted as a default event and trigger massive payouts.

Second, the fact that the weak and strong states are all trussed together by a common currency, but not under a strong central bank. The European Central Bank (ECB) does not have the kind of power to make the quick, enormously expensive decisions needed to calm panicked markets such as that possessed by the Federal Reserve or the Bank of England. How could it? Every member country has one vote, whether that country was Germany or Portugal — and the expansion over the past decade has made decision-making even more difficult, he said. Right now, he says, some important decisions are awaiting the outcome of the Slovakian parliamentary election.

But the right leader could still have overcome this crisis, in his view. The one man who had a chance was an experienced economist, a corporate lawyer, a political veteran, a Frenchman who could speak German, a socialist with a long-standing friendship with George Papandreou, the Greek prime minister, and got along with Jean-Claude Trichet, the ECB president. Beyond that, he ran the International Monetary Fund and was the odds-on favourite for the next French presidential election. However, Dominique Strauss-Kahn's arrest in New York and resignation from the IMF ended that possibility.

Wobbly at the Top

Now that Elvis has left the building, my friend is worried. Almost none of the European financial leadership knows anything about finance, he says. DSK has been replaced at the IMF by Christine LaGarde, a lawyer. LaGarde has been replaced as the French finance minister by Francois Baroin . a 46-year-old politician and former journalist.